501c3 means that a particular nonprofit organization has been approved by the Internal Revenue Service as a tax-exempt, charitable organization. Charitable is broadly defined as being established for purposes that are religious, educational, charitable, scientific, literary, testing for public safety, fostering of national or international amateur sports, or prevention of cruelty to animals and children. A nonprofit organization with a tax-exempt status is not required to pay corporate tax on income that comes from activities that are sufficiently related to its purposes. There is a common misconception that a tax-exempt nonprofit organization is a 501c or 501c3 organization. In actuality, these letters and numbers refer to specific tax categories in the Internal Revenue Code.
Whether it is incorporated or unincorporated, a nonprofit organization is not automatically entitled to federal or state tax exemption. In order to be exempt, the organization is required to meet certain requirements and apply for tax exemption with the IRS and the state. It can become a state nonprofit organization to be exempt from certain state taxes but choose not to become a federal nonprofit organization. Once a nonprofit organization is incorporated, it can apply for federal tax exemption with the IRS or the state. To be eligible for tax-exempt status, the nonprofit must belong to one of the 28 categories of nonprofit organizations, such as research, trade, and religious organizations. After becoming a nonprofit corporation, it may apply for federal tax exemption. The process involves obtaining a federal tax identification number and applying for 501c or tax-exempt status with the IRS. For instance, a trade association will be granted a 501c6 status, while a community recreation organization will receive a 501c4 designation. While a 501c organization does not have to pay taxes on certain kinds of income, it may not be granted a charitable status that enables its donors to write off taxes. The tax-exempt status of a 501c3 organization is granted by the IRS.
Types of 501c3 Organizations
The federal tax code lists several different types of organizations that don’t have to pay income taxes. Here are some of the basic categories:
• Religious organizations
• Educational institutions
• Scientific organizations
• Literary groups
• Groups that test for public safety
• Groups that foster national or international amateur sports competitions
• Anti-cruelty organizations for animals and children
The federal government also classifies private foundations as nonprofit organizations. These types of organizations are largely philanthropic in nature. Because they invest some percentage of their fundraising dollars, the federal government has different rules that they must abide by to maintain their status as a nonprofit organization. Organizations that receive more than one-third of their support from gross investment income are considered private foundations. The IRS requires private foundations to submit detailed tax returns. A 501(c)(3) organization typically begins when a group of people share a common goal of starting a nonprofit organization to fill a need within their community. After carefully choosing a name for the organization, the founders get to work writing the articles of incorporation. The articles of incorporation must include the corporation’s name, contact information, purpose, registered agent, founding directors and information about shares of stock, because once they are filed, they become public record. In most states, founders file the form for the articles of incorporation with the Secretary of State’s office. Organizations usually have to designate an incorporator who signs and files the articles of incorporation with the proper authorities and pays the appropriate filing fee.
There may be separate forms for applying for federal or state tax-exempt status. Bylaws are separate and different from the articles of incorporation. The founding directors write the bylaws, which outline how the nonprofit runs, including the rights and responsibilities of officers and directors. Nonprofit organizations don’t have to file bylaws with the state, but they need to keep them in their files. The next step is usually to appoint a founding board of directors and to hold the first board meeting. After that, the board needs to follow up on obtaining all of the proper licenses and permits, and to open a bank account for the nonprofit’s funds.
Requirements to Maintain 501c3 Status
The government intends for nonprofit entities to remain nonprofit entities, so they set up some rules that tax-exempt organizations must obey in order to keep their tax-exempt status. Not knowing the rules isn’t an excuse for disobeying them. Those who try to blur or cross the line could end up with fines or face other legal consequences.
• Private benefit: Organizations that apply for tax-exempt status cannot serve the private interests, or private benefit, of any individual or organization besides itself past an insubstantial degree. Therefore, a nonprofit may not permit any of its income or assets to benefit insiders, such as board members, officers, directors and important employees.
• Nonprofits are not allowed to urge their members to support or oppose legislation. They may participate in a small amount of lobbying, but lobbying activities may not exceed a certain amount of the organization’s total expenses.
• Political campaign activity: A nonprofit organization may not financially support or endorse any political candidates verbally or in writing. They may not oppose candidates either. This rule applies to candidates at every level i.e. local, state and federal.
• Unrelated business income: Nonprofit organizations aren’t allowed to generate too much income from a purpose that is unrelated to the nonprofit. An organization that regularly operates a trade or business that is unrelated to the nonprofit and makes significant contributions to the organization would need to pay taxes.
• Annual reporting obligation: Nonprofit corporations still have reporting responsibilities, like the Form 990. They may also be responsible for things like tax on unrelated income, employment tax, excise taxes, and certain state or local taxes. Churches and other church-related organizations don’t need to report income.
• Operate in accord with stated nonprofit purposes: An organization that makes a big shift from being unprofitable to making money needs to re-file as a for-profit entity and to pay the applicable taxes.
Dissolving a Nonprofit Organization
It’s much easier to start a nonprofit than it is to dissolve it, and nonprofits must obey certain rules in dissolving their organizations. The intent is to dissuade people from starting nonprofit organizations, shutting them down after a time and keeping the profits for themselves. There are certain steps related to dissolving a nonprofit, and it’s best to gain the help of an attorney or tax professional. A nonprofit may only distribute assets to another tax-exempt organization. The board may vote to dissolve the organization, file dissolution papers with the state and the IRS, and select another nonprofit organization to which to transfer any assets. The board will need to pay all contractual obligations and debts before dissolving the nonprofit. If there aren’t enough assets to pay remaining debts, the nonprofit may need to file bankruptcy. The board could be held liable for not properly dissolving a tax-exempt organization. It’s important to remember that the government values nonprofit organizations for their commitment and sacrifice. The nonprofit savings in tax dollars are intended to serve the public in their communities, not to profit individuals or groups of individuals. The rules and regulations are designed with the intent that nonprofits will start out strong and enjoy long-term sustainability. Nonprofits that decide to close their doors for whatever reason don’t get to pocket any remaining funds. Organizations with 501c3 statuses span a wide variety of industries and service types. One of the main distinguishers of a public charity, at least according to the IRS, is that it isn’t a private foundation. There are many other things that they look for to approve companies for tax-exemption, and they place a heavy focus on revenue sources. The bulk of public nonprofit’s revenue must be provided by public donations or government entities, and one-third of the public donors must be composed of a broad range of backgrounds and classes. The IRS does allow that funds be obtained from individuals as well as companies, and it can also come from other types of charities. Individual donors can write off donations up to amounts that equal half of their yearly income while corporations can only deduct up to 10 percent of their income. There are many similarities between public and private nonprofit organizations, but there are specific differences that the IRS looks for when determining status. While most private organizations are run by families, the rules for a 501c3 charity demand that the majority of the company’s board members are not related. Private organizations aren’t known for their continuously active programs, which is another stipulation for public entities. While they may not technically be active, many private foundations fund the activities of public groups through the use of grants. However, their donor base is usually much smaller than their counterparts because they don’t face the same variety of restrictions. Donors also don’t receive the same deduction opportunities as the IRS limits the claims to 30 percent of their income. It’s not impossible for private foundations to earn 501c3 status, especially if they’re practices result in a hybrid organization, but they’re the smallest type of institution among tax codes. If they do in fact qualify, their donors are able to reap the same tax deduction benefits.
Restrictions on Activities
501c3 organizations face extensive restrictions that are much tougher than other 501c tax code categories. Some of these rules include:
• Individual members or leaders can’t benefit financially from the programs and activities of the organization;
• The assets of a dissolved company much transfer to another 501c3 organization and not to any one person;
• Lobbying should be limited and only use a small percentage of the budget.
• The IRS also prevents organizations from making official ties to political campaigns including candidate endorsements.
In order to obtain 501c3 status, the company or organization needs to complete and file Form 1023. Small entities or those with limited income can use the 1023-EZ Form if they meet the minimal requirements. The IRS requires companies with early earnings of $10,000 or more to pay an $875 filing fee. Organizations with lower revenues are only charged $400 for the application process, but certain entities, like religious institutions, can avoid the entire process as they aren’t required to apply.
The IRS Rule
The IRS uses what is called a facts and circumstances test to help it determine whether an organization has violated the prohibition on political campaigning. This means that the IRS will evaluate any potential misconduct within the context of the organization’s other activities and the current political climate. So, an activity might be considered political campaigning two weeks before an election, but not two years before an election. Some activities that the IRS has found to violate the prohibition on political campaigning include:
• inviting a political candidate to make a campaign speech at an event hosted by the organization
• using the organization’s funds to publish materials that support (or oppose) a candidate
• donating money from the organization to a political candidate
• any statements by the organization’s executive director, in his or her official capacity, that support a candidate
• criticizing or supporting a candidate on the organization’s website
• inviting one candidate to speak at a well-publicized and well-attended event, and inviting the other candidate to speak at a lesser function
• inviting all candidates to speak at an event, but arranging the speaking event or choosing the questions in such a way that it is obvious that the organization favors one candidate over the others
• conducting a “get out the vote” telephone drive in a partisan manner by selecting caller responses for further follow-up based on candidate preference, and using the organization’s website to link to only one candidate’s profile.
A 501(c)(3) organization can engage in the following activities without violating the IRS rule:
• Non-partisan activities: Your organization may engage in non-partisan activities such as non-partisan voter registration drives, non-partisan candidate debates, and non-partisan voter education, as long as these activities fulfill your exempt purposes.
• Legislative or issue advocacy. Your organization can engage in legislative advocacy and issue-related advocacy, as long as it follows certain rules and steers clear of political campaigning. (If your organization is contemplating such activities, it’s a good idea to get advice from a qualified attorney.) And don’t forget that any individuals associated with a 501c3 organization are entitled to voice their opinions and participate in a political campaign, as long as they are not speaking for the organization.
Penalties For Violations
If the IRS believes that your organization may have violated the prohibition, it may send a letter or visit your organization for an on-site examination. Although the IRS has the power to revoke your tax-exempt status, it typically uses this punishment only in the most egregious cases. More likely, the IRS will ask your organization to correct the violation and implement procedures to make sure the violation will not occur again. If the organization’s funds were used to engage in the prohibited activity, the IRS may also impose excise taxes.
501c3 Law Attorney
When you need a lawyer to help you with a 501(c)(3) non-profit entity, please call Ascent Law LLC for your free consultation (801) 676-5506. We want to help you.
8833 S. Redwood Road, Suite C
West Jordan, Utah
84088 United States
Telephone: (801) 676-5506